This hedge fund manager tells how to achieve market success
- Billionaire hedge fund manager David Einhorn says the most important factor for investing success is critical thinking.
“If I had to pick one, I think it is critical thinking skill. It’s the ability to look at a situation and see it for what it is, which isn’t necessarily what is presented to you. And when something makes sense to figure out what makes sense. And when something doesn’t make sense to question it, to challenge it, to look at it from a different way, to often come to the opposite conclusion,” he said in an interview to a financial website.
Einhorn says investors need to bet big when high conviction opportunities come along.
“You don’t have to do it very often. Most of the time when someone tells you something and it makes sense, it just makes sense. And that’s that. But sometimes it really doesn’t make sense … And when you can come to a view maybe just a few times a year, where you have an important difference of opinion with what everybody else is thinking about a particular situation, if you can figure that out and figure it out it is important. We’ve been able to make a small number of large investments that the vast majority of the time, worked out very well,” he says.
David Einhorn is well-known in financial markets as an activist investor and eminent short-seller. He has long been considered one of the most successful and closely followed hedge fund managers in the financial industry.
He is famous for betting correctly with a short position in Lehman Brothers before it collapsed during the financial crisis.
Einhorn is also the president and co-founder of Greenlight Capital Inc. After his BA from Cornell University's College of Arts and Sciences in 1991, he started his career with the hedge fund Siegler, Collery & Co. in 1993.
Greenlight Capital is a New York-based hedge fund founded by David Einhorn in 1996. From inception in May 1996 to the end of 2016, the fund has compounded at 16.1%, significantly outperforming the S&P 500.
Einhorn's firm invests in both long and short-term equities but is mostly recognized for short-selling. It uses a long-short equity strategy in which it takes long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. The firm implements the strategy depending on whether an asset has been termed as undervalued or overvalued.
The fund analyzes various aspects of the market for investment including quantitative analysis, annual filing reports and market sentiment.
The Einhorn effect
In the investment circle, "Einhorn effect" refers to the influence David Einhorn's commentary on markets and specific stocks has on their price.
The market often reacts significantly to Einhorn's public comments on stocks, looking at which the term "Einhorn Effect" was coined.
Investment strategy
Einhorn follows value investing principles and has developed a twist on the regular value investing process. He initially finds reasons for a likely mispricing of assets and then does the traditional value investing analysis rather than doing the traditional value investing analysis first.
According to Einhorn, the reasons for an asset being mispriced include spin-offs, accounting issues and changes in secular or technology trends.
“We take the traditional value investor’s process and just flip it around a little bit. We start by identifying situations in which there is a reason why something might be misunderstood, where it’s likely investors will not have correctly figured out what’s going on. Then we do the more traditional work to confirm whether, in fact, there’s an attractive investment to make. That’s as opposed to starting with something that’s just cheap and then trying to figure out why. We think our way is more efficient,” he says.
Einhorn is a firm believer in taking long positions of companies he believes are undervalued and shorting shares of companies he thinks are overvalued or have accounting issues.
He looks at a company’s intrinsic value in seeking to achieve constant returns.
Einhorn says the task of an investor is to discover puzzle solutions in situations that involve different combinations of risk, uncertainty, and ignorance.
He says the process of discovering puzzle answers is inherently probabilistic in nature.
“What I like is solving the puzzles. I think that what you are dealing with is incomplete information. You’ve got little bits of things. You have facts. You have analysis. You have numbers. You have people’s motivations. And you try to put this together into a puzzle — or decode the puzzle in a way that allows you to have a way better than average opportunity to do well if you solve the puzzle correctly, and that’s the best part of the business,” he says.
Einhorn shared some valuable investing tips that can help investors achieve extraordinary success.
Avoid losses
Einhorn says investors' goal should be to make money, or at least to preserve capital, on every investment and not lose money.
“Securities should be sufficiently mispriced, so that if we are right we will do well, but if we are mostly wrong, we will roughly break even. The trick is to avoid losers. Losers are terrible because it takes a success to offset them just to get back to even,” he says.
Have patience
Einhorn says the objective of a value investor is to buy the assets at a bargain price and then wait patiently.
"Trying to make short-term forecasts instead of waiting is folly and value investors instead rely on the combined long term effects of a buying with a margin of safety knowing that over the long term prices will return to the mean," he says.
Avoid "too hard" investments
Einhorn says if an investment is too hard investors should just move on to the many other opportunities that are not hard.
"Why get involved in investments where you do not know what you are doing especially when there are other bets where you do? Playing against weak competitors is not a sin in investing or business. There are no bonus points in investing for doing things that are really hard," he says.
Have a sound process
Einhorn says a good process can lead to a bad outcome in the real world, just as a bad process can lead to a good outcome.
"Both good and bad luck can play a part in investing results. But the best investors understand that over time a sound process will outperform," he says.
Choose wisely
Einhorn says having the option to make the best choice at a later point in time when investors have more information is valuable since markets are always changing.
“I’m a big believer in not making decisions before they need to be made. Circumstances change, people change, facts change, and options change. Why commit early when you can have the benefit of deciding later with more information?,” he says.
Avoid leverage
Einhorn says the biggest challenge for investors is dealing with unknown unknowns which are the risks that are uncertain in character and magnitude, but that definitely exist.
He says in order to deal with these risks one principle that investors can adhere to is to avoid financial leverage.
“We manage risk by the level of investment that we make. We’re not levered. We don’t borrow more money to make even more investments. That’s one way that you avoid risk, or control your risk. If you don’t ever have to repay anybody, you’re not subject to lending terms and conditions,” he says.
Diversification is important
Einhorn says that even the very best stock ideas have no guarantee of working out as any given company can have any number of hidden risks that investors do not have knowledge of.
He says this is the reason why diversification is so important not because investors' analysis might be bad, but because even the best analysis in the world might not be enough to come to the correct conclusion when faced with the unknown.
He suggests investors to have a risk management system, and to have limits to how much of a losing position they can afford to hold.
Re-evaluate investments from time to time
Einhorn says investors should re-evaluate all of their investments to find out whether they have worked out well or not.
He says once investors have worked this out they should sell or reduce the investments they are not interested in anymore.
"Some that haven’t worked we exit or reduce because we decide that whatever it was we were thinking is no longer true or is unlikely to be born out. We modify the positions accordingly and we do that on a position by position basis and we do that whether things are going well for us or not going well for us. It’s part of our ongoing process,” he says.
Take advantage of market extremes
Einhorn says market extremes do occur since investors do not make decisions independently and are not perfectly informed rational agents.
"The longer your investment timeframe and the lumpier the returns you are willing to accept the happier you will be and the better your returns will be," he says.
Let your investment strategy be challenged
Einhorn says investors should encourage other peers to counter and challenge their investment thesis from time to time which will surely help them in improving their strategy and achieve investment success.
CVC plans Amsterdam listing in blow to London market
Buyouts group is seeking IPO on Euronext exchange
CVC Capital Partners, Europe’s biggest private equity group, is planning to shun London and take its multi-billion-euro initial public offering to Amsterdam’s Euronext exchange.
The buyouts group has told potential investors that it is aiming to list on the Netherlands exchange, and to set a €25bn target for its next private equity fund, according to four people with knowledge of the matter.
No final decisions have been made about the listing or its timing, and much will depend on developments in the war in Ukraine and its consequences for markets, the people added.
However, the choice of Amsterdam over London, by a company that has its roots in the UK capital where it has had a major presence since it spun out of a private equity division of Citigroup in 1993, would be a blow to the London Stock Exchange.
Britain has struggled to attract large and successful listings in the wake of its departure from the EU, which ended regulatory equivalence for financial services. It is working on reforms that attempt to bolster the listings market.
If the plans go ahead, CVC would become the first major private equity firm to list on the exchange, in what stands to become a blockbuster float. The buyouts group was valued at about €15bn last year when it agreed to sell a minority stake to Blue Owl’s Dyal Capital unit.
CVC declined to comment.
Closing Stock Market SummaryThe S&P 500 rose 1.2% on this quadruple witching-options expiration Friday, as the mega-caps carried the benchmark index to its fourth straight advance. The Nasdaq Composite gained 2.1%, the Dow Jones Industrial Average gained 0.8%, and the Russell 2000 gained 1.0%.
There wasn't a specific catalyst today, suggesting that the market was influenced by the following factors: positive momentum after starting the week at an oversold position, technical factors as the S&P 500 reclaimed its 50-day moving average (4433), and short-covering activity from investors caught on the wrong end of the market direction.
The mega-caps were steady leaders throughout the session, lifting the S&P 500 information technology (+2.2%), consumer discretionary (+2.2%), and communication services (+1.4%) sectors to the top of the standings. No other sectors gained at least 1.0%.
The Vanguard Mega Cap Growth ETF (MGK 229.21, +4.95) rose 2.2%, versus a more modest 0.6% gain for the Invesco S&P 500 Equal Weight ETF (RSP 157.17, +1.00).
Conversely, the utilities sector (-0.9%) was the only sector that closed lower. FedEx (FDX 218.91, -9.07, -4.0%) and U.S. Steel (X 32.96, -1.59, -4.6%) were individual laggards after the former missed EPS estimates and the latter guided Q1 EPS below consensus.
The positive bias overshadowed reports indicating slow progress in ceasefire talks between Russia and Ukraine, an underwhelming phone conversation between President Biden and China's President Xi, commentary from Fed officials reminding the market about the need for policy normalization, and a weaker-than-expected existing home sales report for February.
The stock market also appeared unfazed by the curve-flattening activity in the Treasury market, which signaled underlying growth concerns. The 2s10s spread narrowed by six basis points, with the 2yr yield increasing two basis points to 1.96% and the 10-yr yield decreasing four basis points to 2.15%.
The U.S. Dollar Index increased 0.2% to 98.21. WTI crude futures fell 0.4%, or $0.40, to $103.03/bbl. The CBOE Volatility Index fell 7.0% to 23.87.
Reviewing Friday's economic data:
- Existing home sales decreased 7.2% in February to a seasonally adjusted annual rate of 6.02 million (consensus 6.20 million). Total sales in February were down 2.4% from a year ago.
- The key takeaway from the report is that higher mortgage rates and rising prices weighed on sales in February, resulting in the slowest pace of sales in six months.
- The Conference Board's Leading Economic Index increased 0.3% m/m in February following a revised 0.5% decline (from -0.3%) in January.
There is no economic data scheduled for Monday or Tuesday.
- Dow Jones Industrial Average -4.4% YTD
- S&P 500 -6.6% YTD
- Russell 2000 -7.1% YTD
- Nasdaq Composite -11.2% YTD
A Financial Storm Is Brewing in Europe. Where to Hide.
By Reshma Kapadia Follow
Louis-Vincent Gave, co-founder of Gavekal Research, has been warning investors about a paradigm shift in the world order. Specifically, Gave says the assumptions underpinning financial assets need to be rethought due to a move toward a multipolar world and away from one dominated by the U.S. and the dollar. His message seems especially germane now, given Russia’s invasion of Ukraine, the West’s dramatic sanctions, and China’s attempts to support Russia without jeopardizing its economic ties with the West.
Gave, who served in the French army and studied Mandarin at China’s Nanjing University during his undergraduate days at Duke University, co-founded the Hong Kong–based independent macro research firm in 2000, with a focus on Asia. His seventh book, Avoiding the Punch: Investing in Uncertain Times, published last year, provides a framework for helping investors to navigate a period of geopolitical competition, high stock market valuations, and low interest rates.
Gave recently spoke with Barron’s from his office on Canada’s Vancouver Island about why China could emerge as a relative winner from the war in Ukraine. He also explained why long-held assumptions about globalization and the dollar’s dominance need to be reassessed, and why it isn’t yet time to buy stocks, even after their correction. An edited version of the conversation follows.
Barron’s: What is the likely fallout for investors from Russia’s invasion of Ukraine?
Louis-Vincent Gave: We have two crises. The sanctions on Russia have turned an already precarious energy situation into a full-blown crisis. From there, we’re going to have a problem with food costs, which will lead to riots, political uncertainty, and the rise of populist parties in democracies. And we have an unfolding financial crisis. Financial markets are based on trust and everybody playing by the same set of rules. In war, trust collapses and rules change quickly.
The big question is whether the Western world blocking Russia’s foreign reserves and saying, “You thought this money was yours; turns out it isn’t,” acts as an accelerant for a change in the global financial architecture such as we have known it in the post–Bretton Woods era—where all trades are denominated in U.S. dollars, and foreigners earn U.S. dollars and recycle those into U.S. Treasuries, allowing the U.S. to run very large twin deficits with no constraints.
Let’s take energy first. What do soaring prices mean for investors?
China is the big winner. In September, China’s leadership said we are entering an energy crisis and reopened coal mines. Coal is the cheapest way to produce electricity, and the guy with the cheapest cost of electricity typically wins [economically]. From 2000 to 2011-12, that guy was China. Starting in 2012, pollution led the Chinese to [reduce the production of coal].
The mantle of the cheapest energy producer then moved to the U.S. due to the shale revolution. Now, the mantle is moving back to China, which not only has coal but also is going to become one of the only outlets for Russian energy. And better yet, for the Chinese, Russian energy is going to settle in renminbi or gold, not dollars.
Why is that so important?
For years, China had to earn U.S. dollars first to buy energy. The Chinese stockpiled dollars. Now, they don’t need to do that because they are producing domestic coal—priced in renminbi—and they can buy energy from Russia, priced in renminbi that they can just print. In essence, their energy cost is almost free. If China doesn’t need U.S. dollars, does it care about having a positive trade balance with the U.S. through which to generate excess dollars? It doesn’t, so the renminbi could go much higher.
What role do you see China playing in the war?
Having Russia and the Western world at each other’s throats works well for China because they aren’t occupied [with China]. I don’t see why the Chinese would feel a need to stop this. If the embargo of Russia can last forever, so much the better for them. It also helps them internationalize the renminbi. Once China buys all of Russia’s oil and natural gas and coal in renminbi, it is going to turn to the United Arab Emirates and Saudi Arabia and say, “We like your oil so much better than Russia’s. If only you took renminbi, we could do more business.” If you are Saudi Arabia and your biggest client would like to do more business, you have to at least think about it. This is playing into China’s hand.
You have said that you see another financial crisis brewing. Where, and why?
Financial markets need common rules that won’t change, and trust. Today, nobody has a clear vision of European banks’ exposure to Russia—direct or indirect. Banks are hemorrhaging trust and money. You can see this in the blowout in [European] credit default spreads and widening in bond spreads [versus German government bonds]. Also, Europe risks a massive energy shortage, and there’s growing political uncertainty.
How do you see this potential crisis playing out?
Europe’s economic growth will collapse. Over the next six months, inflation that continues to rise will lead to popular discontent. In the fall, Europe may see a massive surge in immigration, similar to the one that followed the Arab Spring, as the surge in wheat prices will create further political instability in the southern and eastern sides of the Mediterranean. Rising inflation plus surging immigration will boost the vote of the populist parties, which will be visible in the Spanish and Italian elections in 2023. While clouds hang over Europe, I wouldn’t be inclined to add risk. You need to see the European situation stabilized.
Where should investors hide?
The first building blocks [of an investment portfolio] are antifragile assets that can thrive when the world falls apart. Pre-Covid, the ultimate anti-fragile asset was U.S. Treasuries. Each time U.S. equities fell 5% or more, [a Treasury holder] made money because yields fell and prices rose. In the past two years, there were five different periods in which the S&P 500 index lost 5% or more. [Owners of] Treasuries lost money in each of those periods.
What’s “antifragile” today?
There are three. Chinese government bonds are one, but they aren’t available to everyone. Gold is another, but it sometimes doesn’t perform. It is rising now because one of the big risks is [the possibility of] a change in the post–Bretton Woods environment. If the world is no longer happy trading U.S. dollars and accumulating U.S. Treasuries, gold benefits.
The third is energy. When you see the bull market dead on the floor with a knife in its back, you round up the usual suspects: too high a cost of capital or too high a cost of energy. Central banks have made it clear they aren’t going to let the cost of capital rise that much, so the big risk is energy.
What goes in the “safe” bucket?
Investors could also seek shelter in U.S. consumer-staples stocks, some healthcare stocks that have struggled, and the Chinese infrastructure companies that have been crushed. If you have to own bonds, you want Treasury inflation-protected securities, or TIPS. But there are better options: Chinese government bonds have outperformed everything else on a one-, three-, five-, and 10-year basis. [Two ways for retail investors to access Chinese bonds: The VanEck China Bond exchange-traded fund (ticker: CBON) and the KraneShares Bloomberg China Bond Inclusion Index ETF (KBND).]
How safe are Chinese government bonds when sanctions froze Russia’s foreign reserves and U.S.-China relations are still fraught?
The argument that you can’t invest because your assets might get frozen didn’t exist until two weeks ago, but it is decently strong now. But the only way you wouldn’t be allowed to own a Chinese bond is if China invades Taiwan, which I don’t think it will.
Why not?
A 60-mile amphibious operation is extremely complicated to pull off with an untested army. If you’re China, you’re looking at Russia and thinking, that seems like a gamble. Russia is also being sanctioned but can take it because it isn’t as integrated into the global economy as China. It would be a gamble [for China], and China’s leaders aren’t gamblers. In crisis moments, they like to maintain the status quo.
What does the changing world order mean for globalization?
The globalization trade that has underpinned almost every portfolio and corporate strategy began to fray with the trade war. It involved not only tech but also energy, commodities, currency. If a U.S. or European company that has outsourced to China sees the sanctions on Russia, they might think, “If China ever invades Taiwan, I can’t have my IT department [there].” Even if sanctions were lifted, who is going to rush back in? The trust is gone. BP had to write off $25 billion of investment in Russia. Before BP goes back in, you’ll need at least a couple of CEOs to forget [this].
How does Russia’s invasion of Ukraine affect China’s calculus around Taiwan?
If Russia puts Ukraine to the sword, and the Western world effectively does nothing, China can say to Taiwan, “Ukraine was a sovereign nation. You’re just a renegade province that nobody recognizes. How convinced are you that the U.S. would back you? Come to the negotiating table, and let’s strike a deal.”
Given the selloff in global stocks, is it time to buy?
Financial crises end with central banks flooding the system with liquidity. We haven’t seen that yet. We have an unfolding energy crisis, which usually ends with a recession. So, no, I’m not rushing to buy.
Thanks, Louis.
A Food Crisis Is Looming. This Fertilizer Stock Stands to Gain.
The invasion of Ukraine could be one of the most disruptive events in the food and agricultural supply chain in decades.
Louai Beshara/AFP via Getty Images
Russia’s invasion of Ukraine, its economic isolation, and the closure of Black Sea ports used to ship goods have created difficult conditions across the world in ways that many have yet to understand.
Russia is one of the world’s largest energy producers, and disruptions in the oil market have attracted intense attention. But less visibly, Russia is also a major producer of nitrogen and other chemicals that are critical to the world’s agricultural crops.
Russia and its ally Belarus represent about 35% of global potash supply and 40% of capacity, according to Goldman Sachs. Russia generates about 15% of global exports of various forms of nitrogen.
David Bertioli, a professor of crop and soil sciences at the University of Georgia, told Barron’s that nitrogen, phosphorus, and potassium affect how much food farmers can grow.
“If you don’t get the proper fertilizers, then agricultural yields will decline, especially in the corn belt in the U.S. and in the wheat belt of Europe,” Bertioli says. He estimated that nitrogen fertilizer supports about half of the world’s population.
Goldman analyst Adam Samuelson recently advised the bank’s clients that the invasion of Ukraine could be one of the most disruptive events in the food and agricultural supply chain in decades.
Some farmers have already complained about difficulty buying fertilizer for crops. A sharp rise in the price of diesel, the primary fuel for tractors and other farm equipment, exacerbates the problem.
Investors concerned by how the war has thrown the fertilizer markets into disarray should consider Mosaic (ticker: MOS). The phosphate and potash crop nutrient company’s price target was just increased by Goldman to $83 from $50, which also raised its rating on the stock to Buy from Neutral.
Samuelson, who follows the company for the bank, told clients that Mosaic is expected to generate “nearly 50% of its current market cap in FCF [free cash flow] over the next three years.” Mosaic’s market capitalization is about $21 billion. During the past 52 weeks, the stock has ranged from $28.26 to $64.71. It is up 47% so far this year and up some 70% over the past year.
Investors can use call options to bet on Mosaic without buying shares outright. With the stock at $57.57, investors could buy the June $60 call and sell the June $70 call to capture any gains before the expected July release of second-quarter earnings.
The call spread—that is, buying a call and selling another with a higher strike price but same expiration—expresses a view that the underlying stock will advance within a specified price range.
The spread costs $3 to implement and is worth a maximum of $7 if the stock is at $70 at expiration. The risk to the strategy is that the stock is below $60 at expiration. Also, if the stock surges far above the short call-strike price, investors won’t participate in those gains.
Of course, if the troubles in Ukraine are resolved, the concerns about fertilizers and the impact on crops that help feed the world should ease. Fertilizer stocks would likely decline, too.
Still, the shadows of Russia’s belligerence shouldn’t be forgotten. Investors should remember that what we eat, and the fuel that we use to power our cars and trucks, connects us to other countries that otherwise seem removed from our lives.
We noted last week that countries with meaningful positions in global commodities could weaponize resources to use to their advantage at a time when the balance of power among the great nations is shifting, and that trend is unlikely to fade even if Russia retreats from Ukraine.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
Europe’s Real Estate Could Offer a Buying Opportunity. These Two Stocks Have an Edge.
Capital & Counties Properties, a British real estate investment trust, owns prime real estate in central London’s Covent Garden.
As war rages on in Eastern Europe and stock markets swing with the latest developments, investors have to work harder to find buying opportunities.
The European real estate sector could be one such place to look. The FTSE EPRA Nareit Developed Europe index, which tracks the performance of commercial real estate companies and real estate investment trusts (REITs) in Europe, has fallen 6.4% year to date compared with an 11% decline for the broader Stoxx 600 index.
The outperformance could be due to its status as a haven investment. Rents are expected to be paid, and while the sector’s growth may slow, rent cuts and space reductions are unlikely, analysts say. Investors still need to be selective—the sector’s selloff has been indiscriminate even though few of the companies and REITs have direct exposure to Russia or Ukraine.
“Despite recent geopolitical events, accelerating inflation and the looming cost of living crisis,” the company’s Covent Garden “retail offer is weighted to high-value luxury retail, which we expect to remain resilient,” says Berenberg analyst Kieran Lee, who has a £2.20 price target.
Barclays has an Overweight rating on the stock. The bank’s analysts said the company could potentially increase rents, given its high occupancy rates. Barclays sees 3% estimated rental value growth a year, up from a flat forecast. Real estate in London’s West End is perceived as a “storage of wealth,” which could make it a defensive play, analyst Sander Bunck says.
Capital & Counties swung to a net profit of £29.3 million in 2021, from a loss of £702.7 million the previous year as rental income rose. The valuation of its Covent Garden properties rose 4.6% on a like-for-like basis to £1.7 billion in the second half of the year, it added.
“Covent Garden is the most vibrant district in the West End and is well-positioned for further rental growth,” CEO Ian Hawksworth said when earnings were released last month.
Shares of British student housing developer Unite Group (UTG.U.K.) were hit hard during the pandemic as universities switched to remote learning. The stock is 17% below its prepandemic high. “We expect a recovery in earnings and dividends to levels ahead of FY2019 and a return to the historic trajectory of growth,” says Panmure Gordon analyst Miranda Cockburn, who rates the stock a Buy with a price target of £12.17. Unite has a “degree of inflation protection” through hedging of utility costs and fixed prices for development contracts, she says.
Analysts estimate Unite’s sales, or rental income, in 2022 could reach £240.5 million ($314 million), and £262.7 million in 2023, according to FactSet, up from £209.1 million last year.
Unite posted pretax profit of £343.1 million in the full-year 2021, up from a £120.1 million loss the previous year. Adjusted earnings rose 20% to £110 million.
The outlook for U.K. higher education is strong, and is driven by increased demand from returning students, Unite CEO Richard Smith said last month at the company’s full-year results.
Barclays analyst Paul May says that demand could be strong in a recessionary environment, which typically makes higher education more appealing.
“This counter-cyclicality is due to people seeing a difficult jobs market and deciding to stay in education for longer,” he said.